Negative yields have vanished from the world’s corporate bond market as investors brace for monetary tightening.
Every single note in a Bloomberg index tracking the global investment-grade corporate bond market yield 0% or more. It is a dramatic turnaround from August, when more than $1.5 trillion of debt, most of it in Europe, came with a sub-zero yield. It marks the end of an era fueled by easy money and extraordinary central-bank policy meant to hold down borrowing costs and stimulate inflation. That was sparked by a combination of the financial crisis and the European debt crisis, followed by the outbreak of the pandemic. Now it’s all going in reverse. Bond yields are soaring around the world and investors are worried that inflation is getting out of control. The Bloomberg global corporate bond index is now yielding about 3.7%, its highest since March 2020, jumping from 1.3% at the end of 2020.
The return of positive yields is good news for anyone that is buying a bond and plans to hold it to maturity. This development makes the global credit market more attractive now. Their average yields are now 1.5% higher than the average dividend yield of the main global stocks included in the MSCI World All Countries index. The current gap between the two yields is the widest since 2011 !
Most strategists say positive yields will remain as long as central banks hold on to their hawkish stance. Group of Seven central banks added about $2.8 trillion to their balance sheets last year, taking total pandemic purchases to more than $8 trillion. They added another $340 billion or so in the first quarter of 2022 – down about 50% from a year earlier – and Bloomberg Economics forecasts their balance sheets will shrink by about $410 billion over the remainder of the year. Even managed at a gradual pace, taking away the punch bowl is always harder than introducing it, especially when central banks are already engaged in a rising rate cycle.
Federal Reserve (Fed) Chair Jerome Powell outlined his most aggressive approach since the mid-2000s to taming inflation and an overheated labor market. The Fed raised its interest rates by 0.75% to a target range of 0.75% to 1% in March and April, after two years of holding borrowing costs near zero to insulate the economy from the pandemic, and signaled five more increases in 2022, finishing this year around 2% and then to about 2.8% by the end of 2023.
Meanwhile traders are betting the European Central Bank will raise rates above zero this year for the first time since 2012, after a string of hawkish comments from policy makers spurred speculation the bank is priming the market for faster-than-expected monetary tightening. The ECB’s deposit rate is currently at a record low of -0.5%.
Investors will probably be reluctant buyers of bonds as long as central banks rates keep moving higher, or until they are more confident about pricing an eventual economic slowdown. The Fed’s history of being able to guide inflation down from 40-year highs with maximum employment suggests a smooth landing is very difficult to achieve! Tighten too slowly and it risks allowing inflation to run out of control, requiring even tougher action. Shift too quickly and the central bank could roil markets and tip the economy into recession. Complicating the job: The war in Ukraine has sent the cost of fuel, food and metals racing even higher, raising fears of 1970s-style stagflation by posing threats to prices, growth and financial-market stability.
In this context, where investment-grade bonds (government and corporate) have lost 12% in 2022 and are on track for the biggest yearly drop since its inception in 1990, volatility in fixed-income markets is likely to remain elevated.
